Page 40 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 25.c: Explain bootstrapping of earnings per share
(EPS) and calculate a company’s post-merger EPS. READING 25: MERGERS AND ACQUISITIONS

Bootstrapping: Packaging the ‘merged’ earnings to show an increase acquirer’s MODULE 25.1: MERGER MOTIVATIONS
EPS, even when no real economic (synergistic) gains have been achieved.

When a high P/E firm acquires a low P/E firm in share for share exchange, the no. of shares outstanding for the acquiring firm increases, but at a ratio that
is less than 1-for-1. This is because in computing combined EPS, numerator, total earnings = sum of the combined firms, but the denominator (total
shares outstanding) is less than the sum of the combined firms.
EXAMPLE: Bootstrapping EPS: Fastgro, Inc., is planning to acquire Slowgro, Inc., in a merger transaction. Financial information for the two companies
both prior to and after the merger are shown below. Calculate Fastgro’s post-merger EPS and determine whether the merger created economic gains.

EPS now $0.2 higher!

Share needed Value of Slowgro
= $$4,000,000/$80 = 50,000 shares = $40*100,000 = $4,000,000

Post merger EPS = $800,000 / 250,000 = $3.20

But market cap is still sum of the two companies’ values prior to the
merger ($16 + $4 = $20 million). No economic gain!
The apparent growth in EPS not from growth in earnings through capital
investment, increased corporate efficiency, or synergistic gains, but rather
from the accounting involved in a stock merger with a low-growth firm.
Market picks this and adjusts post-merger P/E’s downwards accordingly!

From 26 ($80/$3) down to, 25 ($80/$3.2)!